• Acuity shares were hammered as revenue came up short on a double-digit volume decline and management warned of weaker demand in the non-residential vertical.
• Management realizes that selling lighting fixtures isn't going to get Acuity very far, but the shift toward selling more controls, software, and IoT-enabled systems hasn't yet taken off.
• Acuity shares look surprisingly cheap on FCF, suggesting the market may be overly pessimistic about the value of the business as a going concern.

The markets typically care more about margins than revenue … until they don’t. While Acuity Brands (AYI) once again did well on the margin lines, the market seemed more than just spooked by the severe year-over-year erosion in volume. I’d also assume that the weaker call on non-residential construction, one of the markets expected to be stronger for multi-industrials this year, didn’t exactly help matters.

I don’t love lighting as a business and I think Acuity has a long way to go before its more sophisticated control and IoT businesses kick in meaningful contributions. Even so, I’m surprised the shares trade where they do. I mean, I get that the market doesn’t like lighting stories, but that seems overdone here. It’s tough to buy into a sector that I don’t really like, and I know the undervaluation here could persist (particularly if volume stays so weak), but the valuation is enough to make this a name to keep watching.

A Very Mixed Quarter

Acuity shares tend to have outsized reactions to earnings and this was no exception, with the stock getting hammered (down 14%) in response to weak revenue, weak reported EPS, and less than encouraging commentary on the construction market.

Revenue fell more than 10%, missing expectations by more than 4%. On an organic basis, revenue contracted an ugly 13%, with volume down 16% and only mitigated to a minor extent by the 3% improvement in price/mix. While this is only the third volume contraction in the last eight years, it’s the second in a row and the magnitude is pretty startling.

Management noted that retail was down sharply (down over 37%), with volumes hammered by ongoing SKU rationalization (eliminating lower-margin products) and tough year-ago comps from the Lowe’s (LOW) load-in. In the independent/direct channel (which makes up the bulk of the business), sales were down 6% as the 10-Q shows a 5% decline independent sales and a 15% decline in the direct sales network. Revenue in the traditional lighting business was down 15%, while LED lighting revenue was down 8%.